In commonly assigned, U.S. Pat. No. 5,453,601, U.S. Pat. No. 5,557,518 and U.S. patent application Ser. No. 08/427,287, filed Apr. 21, 1995 (corresponding to PCT International Publication WO 96/33476 published Oct. 24, 1996), now U.S. Pat. No. 5,799,087, which are hereby incorporated by reference, an electronic monetary system (EMS) is described that utilizes electronic money that is interchangeable with traditional cash and is universally accepted. The described EMS provides a method and system for securely and reliably transferring economic value including currency and credit among subscribers, among financial institutions, and between subscribers and financial institutions. The EMS also provides for electronic money in the form of multiple currencies.
Foreign exchange trading has grown from $1 billion per day in 1974 to almost $1 trillion per day in 1994. Hundreds of billions of dollars per day pass through the international payment systems to settle these transactions. The risk of failure by any of the participants has the central banks of the major economies concerned. These concerns and potential solutions were set out in the report by the Bank for International Settlements "Central Bank Payment and Settlement Services with Respect to Cross-Border and Multicurrency Transactions." This report spawned two responses from the private sector: "Reducing Foreign Exchange Settlement Risk" by the New York Foreign Exchange Committee and "Risk Reduction and Enhanced Efficiency in Large-Value Payment System: A Private Sector Response" by the New York Clearing House Association.
The problem was first demonstrated in 1974 when the Herstatt Bank in Germany was declared insolvent at the end of the banking day. Foreign exchange trading is by convention settled two business days following the trading day. This is termed the value day. In order to settle a dollar Deutsche Mark trade, for example, funds have to be transferred between the counterparties dollar accounts and their Deutsche Mark accounts. These transfers are made final at the appropriate central banks, i.e., the Federal Reserve and the Bundesbank. Since Germany is seven hours ahead of the time in New York, the Bundesbank closes before the Federal Reserve. Thus the transfer of marks could be final before the dollars transferred. If the counterparty to the Herstatt Bank had paid his marks and had not received his dollars by the end of the banking day in Germany, then the marks could be lost. This risk is called foreign exchange settlement risk or Herstatt risk.
All of the foregoing reports suggest solutions incorporating extended banking hours, coordinating central bank accounting systems, and setting up multicurrency clearing banks. Each of the proposed solutions reduces the risk but does not eliminate it. We propose a system to eliminate the risk which incorporates EMS with an augmented transaction called Settle Foreign Exchange which eliminates the risk by coordinating the multicurrency payments outside the central bank systems.